Multiple Buffer CoCos and Their Impact on Financial Stability
Tinbergen Institute Discussion Paper 2020-010/IV
48 Pages Posted: 12 Mar 2020
Date Written: January 29, 2020
In this paper we develop a theoretical model to investigate the effect on a bank's financial stability of having multiple contingent convertible bonds buffers (CoCos) on the same bank balance sheet, using cash-in-the-market pricing and global games methodologies. Contingent convertible bonds are meant to act as a bail-in mechanism for banks, where CoCo debt converts into equity when a bank needs it the most. We find that having CoCo buffers which trigger at different capitalisation levels can be detrimental for the CoCo bail-in capacity. Market-based triggers lead to premature conversion and fire-sales of equity. In contrast with existing literature, we show that book-based trigger CoCos yield an optimal outcome, as long as they incorporate expected credit losses.
Keywords: contingent convertible bonds, fire sales, financial stability
JEL Classification: G38, G21, G32
Suggested Citation: Suggested Citation